By Russ Banham
Like everyone else, Peter Lacovara is coping with COVID-19, working at home to limit contagion to the coronavirus and stay healthy. He’s also plugging away trying to keep businesses healthy, as well.
In his role as a senior vice president and leader of Marsh’s Alternative Risk practice, Lacovara has been fielding emails and phone calls from risk managers about PathogenRX, the broker’s innovative parametric insurance policy developed with Munich Re and technology firm Metabiota. The policy, designed to provide business interruption insurance in the event of a pandemic, is the only one of its kind.
The emails and phone calls to Lacovara do not involve claims, as not a single company bought the parametric insurance product following its launch in May 2018. Now, of course, every risk manager is hoping they can still buy it.
“As you can imagine, there’s an enormous amount of demand for the product right now,” said Lacovara, who joined Marsh in January, scant days after the coronavirus began inconspicuously spreading from Wuhan, China, to other parts of the world. “Risk managers have become painfully aware their property insurance policies exclude pandemic events.”
While there may still be time to buy the product for a future pandemic, COVID-19 is off limits. “Unfortunately, it’s too late. The coronavirus is excluded from coverage,” he said. “That would not have been the case as recently as last November. But you can’t buy insurance for your house when it’s already on fire.”
Too Late, Too Little
It would be insensitive to fault companies for not buying PathogenRX prior to COVID-19’s entrance on the world stage. No other pandemic or epidemic in recent history has had such a startling impact on global economies and industry sectors. Certainly, every government, every business, was caught by surprise.
In hindsight, however, the insurance product was the most opportune way for companies to transfer the business interruption risks caused by a pandemic. As every risk manager knows, to be covered for revenue losses caused by an interruption in business, physical damage must occur to the insured facility. Without damage, there is no insurance reimbursing the lost revenue.A few risk managers are said to have put together so-called “manuscripted” or customized policies in which this physical damage requirement was waived, but the policies most likely carried the usual communicable disease exclusion, according to an insurance broker who provided comments off the record. The exclusion was tacked on to virtually all property and casualty policies in the aftermath of previous epidemics and pandemics like SARS, Swine Flu and the Ebola virus.
“It’s possible that some companies have coverage for business interruption losses caused by the coronavirus, but it all depends on the policy wording,” the broker said. “At this point, we just don’t know, but I can’t imagine that more than a few companies have coverage.”
At least one lawsuit has been filed over the availability of coverage. According to the court declaration, the owner of the Oceana Grill restaurant in New Orleans maintains that the wording of its property insurance policy indicates insurance coverage picking up business income losses caused by a pandemic.
The plaintiff’s all-risks insurance policy, purchased from a Lloyd’s of London syndicate, lacks an exclusion for business income losses caused by a viral pandemic, the court record states. And it appears to provide insurance for business losses attributed to a shutdown by a civil authority, the case with COVID-19 in the city. (Editor’s Note: Several other lawsuits have been filed against other insurers since this article was written, including suits brought by restaurant owners in California and Chicago, and casinos in Oklahoma.)
While it was unclear at press time if Lloyd’s had sold similar policies to other businesses, these companies nonetheless would represent a sliver-thin slice of the overall insurance market, a broker told Carrier Management. Virtually all companies bought a traditional property insurance policy, which absorbs business interruption losses only when the insured premises are physically damaged by an event precipitating the claim.
In hindsight, companies could have transferred the business interruption risks of COVID-19 by purchasing PathogenRX or other parametric products marketed by insurers and the ILS (insurance-linked securities) market, which sources risk-bearing capital from investors.
Although these alternate parametric products don’t reference a pandemic per se as the triggering event, they provide a payout for events related to the health crisis, such as a decrease in the volume of hotel guests. As Matt Dyk, assistant vice president at broker Gallagher, put it, “Products written on a parametric trigger basis existed to address the business interruption coverage gaps in property insurance policies. The problem is very few businesses took up the offer.”Lavocara agreed. “Prior to the pandemic, we had many conversations with clients in the hospitality, gaming and sports industries about PathogenRX, but interest and exploration in the policy was modest,” he said. “Given the number of inquiries we’ve received following the coronavirus outbreak, we expect that to change dramatically in the future.”
Pulling the Trigger
So, what is parametric insurance? As Carrier Management reported in July 2019, the product is a novel form of risk transfer in which a pre-established payment to the insured party is made upon the occurrence of a specific catastrophic event.
Historically, the policy has been used to absorb the business income losses caused by low-frequency, high-severity natural disasters like a devastating earthquake or hurricane, with the magnitude of the earthquake and the wind speed of the hurricane serving as the parameters or metrics that activate the insurance. An independent, verifiable third-party organization provides this metric. In the above scenario, the U.S. Geological Survey (USGS) delivers the earthquake magnitude and the National Oceanic and Atmospheric Administration (NOAA) provides the windspeed.
In the years since the first parametric products were written in the 1990s, the coverage has evolved to absorb diverse economic losses for a wide range of enterprises. Parametric policies have been constructed to absorb business interruption losses for vineyards caused by unusual frost depth. Promoters of outdoor concerts and sporting events can buy parametric insurance to absorb business losses attributed to cancellation, with rainfall volume as the trigger. Parametric policies also have been sold to travelers to absorb air flight delays.
Of most interest in the current global health crisis, broker Aon created a parametric product in December 2018 for use in the hospitality sector. The product provides a specified insurance payout if an event like a pandemic or the grounding of planes causes a decrease in average hotel bookings during the coverage period. The payment is triggered by a reduction in hotel room rate revenue compared to historical averages.
The product is an example of a parametric policy offering business income protection without specifically linking the trigger to a pandemic like PathogenRX. At this point, it is unclear how many hotels, if any, purchased the product or which carriers provided capacity. Aon did not respond to requests for an interview.
The insurance may have been offered by Lloyd’s of London. Reuters reported on March 3 that a hotel-focused parametric product was offered widely by Lloyd’s. Reuters’ reporters, however, were unable to secure comments from Lloyd’s and three large hotel chains on the product’s uptake.
Had hotels acquired the product, it would have provided a means of passing on the besieged industry sector’s business losses. “The impact of COVID-19 on the hotel industry has been among the most severe in any sector,” said Jan Frietag, senior vice president at STR, a hotel analytics firm. “Room occupancies in China and Italy plummeted 90 percent over a two-week period to the single digits. In the U.S., for the week ending March 14, hotel occupancy stood at 53 percent, but as more people stay at home and practice physical distancing, we expect the rate to deteriorate—maybe not to the single digits, but that is not out of the realm of possibility.”
Coming out of the Shadows
A major reason for the popularity of pandemic insurance is the certainty the product provides when a stated type of business income loss occurs. In contrast with the lengthy and sometimes disputatious claims adjudication and payment processes involved in traditional insurance, once the triggering metric in a parametric policy is attained, the payment is instantly made to the buyer.
“The underlying data triggering the insurance is evident to all parties, ensuring a quick and seamless payout,” explained Robert Hartwig, former chief economist at the Insurance Information Institute and presently a finance professor at the University of North Carolina’s Darla Moore School of Business.
Parametric products are useful for risk-based events beyond those insured by traditional insurance. “Parametric insurance works well when trigger events are easily defined by reputable governmental organizations, such as a hurricane, tornado or even a pandemic,” said Kaenan Hertz, managing partner at Insurtech Advisors.
Gunther Kraut, head of Epidemic Risk Solutions at Munich Re, which underwrites PathogenRX, agreed that parametric insurance can compensate for drawbacks in traditional insurance.
“The decision between parametric and indemnity-based solutions always is a balance of various factors, such as affordable premium and ease of claims settlement,” he said. “In the case of epidemic or pandemic risk insurance, carriers also are enabled to do a certain degree of risk layering to increase insurability.”
Hertz cited another compelling reason for insurers to sell parametric insurance and for companies to buy it: the ability to develop “smart” business interruption insurance policies using a blockchain technology platform.
“Parametric insurance, coupled with blockchain ledger technologies, shows great promise, since once an event has been triggered, the smart contract can pay out with limited human involvement,” he said. “Assuming this is the case, insurers can offer risk managers frictionless sales, claims and service experiences, in turn saving carriers millions of dollars in traditional onboarding and claims processing.”
Like all things that look too good to be true, there is a shortcoming to parametric products. Risk managers must balance the certainty of the insurance payout against the policy’s basis risk, the possibility that the triggering metric-like volume of rainfall or depth of frost does not reach the stated level to result in a payout. It’s an all-or-nothing proposition.
Nevertheless, with the traditional insurance markets unlikely to exclude property damage to provide business interruption coverage, much less strike the current communicable disease exclusion, parametric insurance appears to be the best option at the moment to transfer future pandemic risks.
This possibility explains the parade of phone calls and emails to Lacovara asking for information on PathogenRX. “I’m fielding calls every day from risk managers asking how it works,” he said. “They’re expecting to see even stricter pandemic exclusions in more traditional policies going forward.”
Lacovara cautioned that PathogenRX at some point will run out of insurance capacity. “Munich Re can write only so much of the product before the capacity dries up, otherwise it would take up all of its balance sheet,” he said. “Other insurance markets and ILS investors will need to provide reinsurance capacity.”
Dyk anticipates that the insurance, reinsurance and ILS investor markets will step up to this opportunity. Although he was uncomfortable predicting the future when the present time is so fraught with uncertainty, he’s received “fluid evidence,” he said, of “an appetite to absorb pandemic risks on a parametric basis going forward.”
In this regard, he projects evolutions in the product. “Possibly we’ll see a secondary trigger like the number of total deaths added to a primary trigger like how much revenue is lost or a decrease in the number of hotel guests or the period of time a facility is shut down,” he said.
There’s also a distinct possibility that insurers and reinsurers may provide specific insurance policies in the future designed to absorb pandemic-caused business income losses. “I think we’ll see a change in the market in the next five years, where we have traditional insurers covering this explicitly in separate standalone policies,” Lacovara said.
Key to this possibility appears to be the federal government’s willingness to create a structure similar to the Terrorism Risk Insurance Act (TRIA) for insurance claims related to a pandemic. TRIA is a federal backstop for insurance claims related to acts of terrorism. “Were the government to take this step, it would give more confidence to insurers and investors (in the ILS market) that there is risk-bearing capacity for them beyond a certain loss limit,” said Dyk.
If other countries with TRIA-like reinsurance pools created similar structures for pandemic-caused business interruption losses, insurance and reinsurance capacity would enlarge even more, he added.
Until then, parametric insurance may be the only way to spread the business losses of another pandemic, either through PathogenRX or some other parametric product. Lacovara is expecting the deluge of risk manager queries not to abate any time soon.
“Like everyone, I’m hoping not to see another pandemic in my lifetime,” he said. “But my role, for the time being, is to provide opportunities for companies to apply parametric products to reducing the business impact of the next one.”
Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.